I have been thinking about international bonds and specifically a couple of items that we investors may not have the answers to at this point:

1) How would these bonds perform during market stress? The next crisis? Domestic bond funds for the most part perform well and provided safety and income.

2) Vanguard's International Bond Fund - In reading the annual report, it appears the bond has derivatives to hedge. How would this fund perform if there was a crisis or freezing int eh derivatives markets?

3) Yield - The performance of a bond bond is essentially the yield. Vanguard's fund has a yield that is much less than the Total Bond Index fund. Why would investors or a retiree who may need the cash flows from dividends invest in this lower performing fund?

John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" |
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Disclosure: Three Fund Portfolio + U.S. & International REITs

Vanguard has a lot of information on this. There are videos and white papers. Remember that Vanguard will always focus on the total return of your portfolio. They will few most bond funds as a stabilizing couterweight to equities, and they won't usually few bond funds solely in the context on income-producing investments. This is a snippet to introduce you:

1) How would these bonds perform during market stress? The next crisis? Domestic bond funds for the most part perform well and provided safety and income.

Depends on credit quality, duration, sources of market stress. You could see more FX movement one way or another. For high quality bonds, it shouldn't make much difference the country where it is issued if there are concerns about credit. On the other hand there are other scenarios bonds don't do well, but it's not like an inflation shock would sit well with domestic bonds either.

2) Vanguard's International Bond Fund - In reading the annual report, it appears the bond has derivatives to hedge. How would this fund perform if there was a crisis or freezing int eh derivatives markets?

Vanguard's fund is currency hedged using 1-month forward contracts with a number of large banks with international operations. That virtually zeroes out the effect of FX movements. The forward contracts aren't really part of the derivatives market in the sense of there being a standardized exchange and trading. It's not like futures. These are two-party agreements. It's unlikely there's substantial counterparty risk that develops in the span of a month, where you think the bank might not actually be able to pay up the potential profit from the foreign currency appreciating against the USD (if it's the other way, the fund is the one losing money to the other side). They likely have cash flows and assets in the other currency anyway.

In any case, it's not like it's all the fund assets subject to counterparty risk, just the currency hedging that in theory might be broken if these banks actually renege on contracts. It's possible some institutions might not want to enter new forward contracts, at least not with a little higher expense, but that would be something we could find out as it's happening.

3) Yield - The performance of a bond bond is essentially the yield. Vanguard's fund has a yield that is much less than the Total Bond Index fund. Why would investors or a retiree who may need the cash flows from dividends invest in this lower performing fund?

No, you're missing the hedge return. The forward contracts account for the difference in short-term interest rates in different currencies (or else there'd be easy money to make). Currently when you hedge many of the developed market currencies back to USD, you earn this additional return on top of the local currency bond return.

For example currently the spot rate for EUR/USD is 1.1853 but the 1-month forward rate is about 1.1872. You get some extra Euros when trading in your USD in a month, because you'd earn more in T-bills and other short instruments in USD than you would with equivalent things in EUR. That difference comes out to about 1.94% annualized that a US investor might see hedging Euro-denominated bonds back to USD (on top of the EUR return of the actual bond).

Unhedged International Bonds may offer currency diversification with resultant rebalancing opportunities.
Unlikely to appeal to many/most investors on their supposedly defensive side.
But they are after all part of the total Global investable assets.

One aspect that surprised me and really shows we live in a global world was when I read the annual report for Total Bond was the international companies who issue bonds in the U.S. Likewise the Total International Bond fund contains U.S. companies who issue bonds overseas.

These funds are not in isolation or silos.

John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" |
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Disclosure: Three Fund Portfolio + U.S. & International REITs

I have an experiment to report on international bonds that I started somewhere in the early/mid 90-ies. One of the top funds (according to Morningstar) in the category at that time was Scudder Intl. Bond. I bought a small lot of shares and let it rip (with dividend re-invested) until just last month. Turned out to be one of the worst performing investments I have made so far - outside of riding MCI/Worldcom all the way to zero, back in the day...
Don’t know if the fund is still considered a “strong performer in its category” now, but I’m glad I finally ditched it. Not doing intl. bonds anymore - with currency fluctuations and crazy low interest rates all over Europe, its way too complicated for me to understand The older I get, the more I value simplicity.

I wonder why people who add international bonds don’t consider adding emerging market bonds as well.

As pointed out in other threads vanguard is using 30% of FI in Int. bonds. If you look at the global market cap it’s around 39% TBM, 43% Int Bonds, and 18% EM bonds. Based on JPMorgan numbers.

I’m not saying to hold global weight, but I’m suggesting keeping the relationship. Instead of holding 30% of FI in Int Bonds why not 20% Int Bonds and 10% EM Bonds? This would change the return and yield.

This mix of Int Bonds + EM Bonds would have a YTD of about 4.2% which is nicer than the 2.4% of Int Bonds.

Total Bond may satisfy one professional's minimum allocation to international, then to another "professional" not even make a dent. There are those here that seem to have quite a bit of International Bond, some not so. Who's correct?
Though past performance. . .and all that. . . on Morningstar side by side with Vanguard Total Bond, Vanguard Total International only goes back to 2013 so it seems it's still the new kid on the block.

Last edited by Sandtrap on Fri Nov 24, 2017 2:17 pm, edited 3 times in total.

I wonder why people who add international bonds don’t consider adding emerging market bonds as well.

As pointed out in other threads vanguard is using 30% of FI in Int. bonds. If you look at the global market cap it’s around 39% TBM, 43% Int Bonds, and 18% EM bonds. Based on JPMorgan numbers.

I’m not saying to hold global weight, but I’m suggesting keeping the relationship. Instead of holding 30% of FI in Int Bonds why not 20% Int Bonds and 10% EM Bonds? This would change the return and yield.

This mix of Int Bonds + EM Bonds would have a YTD of about 4.2% which is nicer than the 2.4% of Int Bonds.

For the above I used Vanguard ETF numbers.

Note: I am not an expert. I’m only trying to learn.

You might well add emerging market bonds. However, you're going to ultimately get back to why you're holding fixed income investments in the first place. There are two extra things to consider with emerging market bonds:

1. The quality of the emerging market debt may not fit with your requirements. By definition, they're going to be riskier.
2. The emerging market bond funds are not hedged. Therefore, not only are you making a play on the debt itself but also on currency variation.

Because of the two items above, you're going to probably have more equity-like moves than fixed income stability. If you're also invested in high-yield debt (like your typical junk bond fund), then the emerging market fixed income funds might fit your needs. If you're using extremely conservative criteria (highest credit ratings, etc.) to pick your fixed income investments, you're probably not going to be interested in emerging market debt.

2. The emerging market bond funds are not hedged. Therefore, not only are you making a play on the debt itself but also on currency variation.

Generally you can get either EM local currency bonds, or EM bonds sold in major currencies. There are a lot of USD-denominated EM bond funds. Vanguard's EM bond index fund is USD denominated.

So there is no explicit "currency variation" effect and risk unless you're purposefully seeking local currency bonds and want it. Just maybe extra credit risk in the form of the issuer not being able to pay if FX swings very much against them (in your favor), when there is big trouble.

I wrestle with this whole asset class. One one hand Vanguard investment experts now recommend this asset class with a recommended allocation of 30% of fixed income. However, many investment experts such as Jack Bogle, David Swensen, and even Warren Buffett do not recommend an allocation.

Most experts recommend Total Bond Index, Treasuries, and TIPS.

Last edited by abuss368 on Fri Nov 24, 2017 1:30 pm, edited 1 time in total.

John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" |
|
Disclosure: Three Fund Portfolio + U.S. & International REITs

2. The emerging market bond funds are not hedged. Therefore, not only are you making a play on the debt itself but also on currency variation.

Generally you can get either EM local currency bonds, or EM bonds sold in major currencies. There are a lot of USD-denominated EM bond funds. Vanguard's EM bond index fund is USD denominated.

So there is no explicit "currency variation" effect and risk unless you're purposefully seeking local currency bonds and want it. Just maybe extra credit risk in the form of the issuer not being able to pay if FX swings very much against them (in your favor), when there is big trouble.

Yes, correct. Both USD-denominated and local currency funds/ETFs exist so you’d want to decide how you’d want to play it.

As far as the Vanguard Total International Bond Index, this one is not "battle tested" a la Vanguard Total Bond Market Index, in other words, we know how the Total Bond Market Index performed during the last market debacle [it passed the test] . . . will the Total International Bond Index pass a market debacle test? Stay tuned. Good luck. Merry Christmas. Thanks for reading.

As far as the Vanguard Total International Bond Index, this one is not "battle tested" a la Vanguard Total Bond Market Index, in other words, we know how the Total Bond Market Index performed during the last market debacle [it passed the test] . . . will the Total International Bond Index pass a market debacle test? Stay tuned. Good luck. Merry Christmas. Thanks for reading.

Hi cfs -

That is exactly one of my points and reasons for starting the thread. I am curious in the next market pullback.

John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" |
|
Disclosure: Three Fund Portfolio + U.S. & International REITs

One aspect that surprised me and really shows we live in a global world was when I read the annual report for Total Bond was the international companies who issue bonds in the U.S. Likewise the Total International Bond fund contains U.S. companies who issue bonds overseas.

These funds are not in isolation or silos.

This was a surprise to me too. I can just hear John Bogle saying that you don't need International Bond funds because you have International representation within US Total Bond.

I own a couple of International Bond funds but have not added to them for a while now. They are probably 6%-7% of my fixed income holdings. My experience with them has been mixed, but then again, they are not currency hedged as the Vanguard product is. I view International Bonds as an entirely optional investment. Vanguard does believe that there is a diversification benefit to owning them, my guess is that the benefit is pretty minor.

One aspect that surprised me and really shows we live in a global world was when I read the annual report for Total Bond was the international companies who issue bonds in the U.S. Likewise the Total International Bond fund contains U.S. companies who issue bonds overseas.

These funds are not in isolation or silos.

This was a surprise to me too. I can just hear John Bogle saying that you don't need International Bond funds because you have International representation within US Total Bond.

I own a couple of International Bond funds but have not added to them for a while now. They are probably 6%-7% of my fixed income holdings. My experience with them has been mixed, but then again, they are not currency hedged as the Vanguard product is. I view International Bonds as an entirely optional investment. Vanguard does believe that there is a diversification benefit to owning them, my guess is that the benefit is pretty minor.

True. I am curious if the benefit will increase over time as we become a more global investment market.

John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" |
|
Disclosure: Three Fund Portfolio + U.S. & International REITs

One aspect that surprised me and really shows we live in a global world was when I read the annual report for Total Bond was the international companies who issue bonds in the U.S. Likewise the Total International Bond fund contains U.S. companies who issue bonds overseas.

These funds are not in isolation or silos.

This was a surprise to me too. I can just hear John Bogle saying that you don't need International Bond funds because you have International representation within US Total Bond.

I own a couple of International Bond funds but have not added to them for a while now. They are probably 6%-7% of my fixed income holdings. My experience with them has been mixed, but then again, they are not currency hedged as the Vanguard product is. I view International Bonds as an entirely optional investment. Vanguard does believe that there is a diversification benefit to owning them, my guess is that the benefit is pretty minor.

True. I am curious if the benefit will increase over time as we become a more global investment market.

That is a big unknown. A lot will depend upon whether the US Dollar remains the world's reserve currency and if the US retains its unique competitive advantages around the world. The future is unknown and thus I advocate investors think in terms of a world-wide portfolio. Vanguard presently recommends 40% of stocks and 30% of bonds in International investments.

Global Aggregate (hedged) would be between Global Aggregate ex-USD (hedged) and US Aggregate. The Vanguard and iShares hedged international bond funds should be very similar to the Global Aggregate ex-USD (hedged).

im New to investing this last year. It’s been a long year of reading. What I settled on is slightly unorthodox but I feel ok about it especially in the early stages of my investing.

I have a 90/10 AA split right down the middle between global and domestic markets.

For my stock I am 50/50 between VTI (TSM) and VT (Total World).

My FI I do the same thing. I know that with only having 10% FI it doesn’t matter what I do, but I am using this time to learn more about FI.
So I have 5% at global weight. Which is 2% TBM, 2% TIBM, and 1% EM Bonds.

The other 5% I hold domestically and have it in TBM.

So when I add it up it puts me overall at 25% INT stock and about 30% FI International.

What I like about this is I’m within Vanguards FI recommendation and also in Bogle’s 20% INt range.

Beyond that, I like that the global half of my portfolio will fluctuate over time, while still having a tilt to domestic stocks.

Going back to Bonds, to me I think the people who begrudgingly added them would never consider EM Bonds. The people who wanted the diversification are probably open to them.

Even though I know nothing, I have never complained about the lack of yield from Int Bonds because that small portion of EM bonds made up for what TIBM lacked.

I will be very interested in this asset class in 10 years, if within that 10 years the bank of japan and the european central bank stop flooding the market with their bonds. Not much diversification in the international bond fund, because it is who issues the most bonds, who you end up owning the most of. So in theory Japan could triple its bond issuance and you would in fact be forced to buy their bonds because it's market cap as a total of international bonds is increased. Typically a country needing to flood the market with bonds isn't in great shape. I don't personally feel comfortable with it yet, until this whole bond issuance thing winds down hopefully in 10 years.

Secondly, its very hard to understand what in the heck I am investing in, besides I understand their is a yield to the bond and it is hedged so I don't have any currency fluctuations that impact the return. Still too new for me, not battle tested, and the EURO and BOJ are still in panic mode issuing and keeping the Zero interest rate policy. But that will come to and end hopefully and I will want to see the impacts on the fund.

For me, maybe once these bonds cycle through the fund a little, and it gets battle tested - then I'll consider. Otherwise I'll stick with the mighty USA bond index, with a country surrounded by two huge oceans, and friendly neighboors, and the biggest military in the world. I'll expect to be paid back. Not putting my money in bonds from a small little Island (Japan) surrounded by hostile neighboors and drounding in debt about 3X more than the USA. I'd appreciate a European/UK mixed hedged bond fund, I just don't want to own a bunch of japanese bonds, and neither for the forseeable future...to sleep at night. But, who knows. Just not with my money

Global Aggregate (hedged) would be between Global Aggregate ex-USD (hedged) and US Aggregate. The Vanguard and iShares hedged international bond funds should be very similar to the Global Aggregate ex-USD (hedged).

Thanks for the chart. I suspect that international bonds won't have much of an affect on total returns over the long term. However, some experts believe that the only free lunch is diversification. OTH, some experts believe that the negative interest rates scenario will end badly. I'm going to take a wait and see approach since I have no idea what will happen.

I will be very interested in this asset class in 10 years, if within that 10 years the bank of japan and the european central bank stop flooding the market with their bonds.

I found this to be very confusing.

The European Central Bank, through a programme of Quantitative Easing, is buying up Eurozone government debt (and some other forms of investment grade debt). Thus reducing the supply of bonds.

The ECB does not issue bonds. Neither does the Bank of Japan. The issuance of bonds is by the member governments of the Eurozone.

The B of J is targetting a higher inflation rate of 2.0% (from a country that has experienced deflation i .e. an actual fall in prices since the mid 1990s), by the printing of money (buying bonds and printing currency and not taking fully offsetting sterlization activites.

Which do you mean?

Not much diversification in the international bond fund, because it is who issues the most bonds, who you end up owning the most of. So in theory Japan could triple its bond issuance and you would in fact be forced to buy their bonds because it's market cap as a total of international bonds is increased. Typically a country needing to flood the market with bonds isn't in great shape. I don't personally feel comfortable with it yet, until this whole bond issuance thing winds down hopefully in 10 years.

There is that risk there. However in an efficient market, if Japan issues too many bonds, the market will become aware of the risk of restructuring or default, and therefore lower the value of Japanese bonds-- their yields will have a meaningful default risk priced in (lower price, higher yield). As at the moment that seems unlikely as JGBs are yielding c. 0.5%.

Secondly, its very hard to understand what in the heck I am investing in, besides I understand their is a yield to the bond and it is hedged so I don't have any currency fluctuations that impact the return. Still too new for me, not battle tested, and the EURO and BOJ are still in panic mode issuing and keeping the Zero interest rate policy. But that will come to and end hopefully and I will want to see the impacts on the fund.

Again I am not sure what you mean?

ECB and BOJ are both fighting deflation. They had to be dragged to his point over a number of years-- remember ECB *raised* interest rates just before the Greek Crisis in 2012.

For me, maybe once these bonds cycle through the fund a little, and it gets battle tested - then I'll consider. Otherwise I'll stick with the mighty USA bond index, with a country surrounded by two huge oceans, and friendly neighboors, and the biggest military in the world.

In a world of long range weapons, unfortunately where you are located no longer matters-- FDR and George Marshall understood this (without the missile factor) in setting US strategy pre WW2. So did President Truman.

Yes the military is large, I'd urge you to read the recent Heritage Foundation report on military readiness, though, it was depressing reading.

The USA reminds me of Great Britain, but whether in 1900 or 1939 is an interesting point.

In a globalized world what matters is your interrelationships. The US has rising oil production so that obvious vulnerability is being reduced (but one would still be in trouble economically if say oil went to $200/bl due to geopolitical disruption of supply). Even though the Internet is an American creation, the US is vulnerable to cyber attack, say, or a super solar flare. It imports lots of other key raw materials and manufactured items of course (it's almost impossible these days to say where a manufactured good is "made" as opposed to where is it assembled?).

The point of the US is that it controls its own currency. It need never default on its debt (except for legislative reasons) but simply can print money.

BTW the same is true of Japan.

I'll expect to be paid back. Not putting my money in bonds from a small little Island (Japan) surrounded by hostile neighboors and drounding in debt about 3X more than the USA. I'd appreciate a European/UK mixed hedged bond fund, I just don't want to own a bunch of japanese bonds, and neither for the forseeable future...to sleep at night. But, who knows. Just not with my money

International bond indices of course also include Australia & Canada, Sweden & Switzerland (not in the Eurozone).

The gains from a currency hedged investment grade government international bond fund are :

- real interest rate cycles are different across different nations, therefore you get some diversification benefit (Swensen estimates c . 1.0% pa real, which is significant - but that is old data)

- credit risk diversification - I would argue that a US default (the theoretically risk free bonds) would cause so much havoc in international capital markets (and is so unlikely) that primarily what you are doing is diversifying into *worse* credit risks. That should give you higher yield, but also greater volatility.

If currency is unhedged then what you have is a currency speculation fund. The bond returns will be very small compared to that volatility.

I own the vanguard emerging market government bond fund. It is USA dollar denominated as 10% fixed income the rest in the total bond index fund for bond diversification and yield. The low yield and high duration of the total international bond fund currently prevents me from adding this asset to my portfolio. I will wait until the yield of the total international bond index fund is significantly higher before adding this fund. However, the Vanguard Global Wellesley Income Fund may be a reasonable way to add some international bonds. I have not researched it yet. 30% of it's bonds are Baaa, and it is an active fund. It is not a pure bond fund.
jc

I live abroad in a small, developing economy ... and I can't realistically invest in the local currency for various reasons. So I would love to own some unhedged international bonds to better diversify away from the dollar. But I have never found good value to do that ... the closest are probably the two ishares goverment bond ETFs but their expense ratios are 0.35%. I might be interested at 0.25%.

Even with almost 60% of my equities international, I am only about 36% non-dollar denominated since all bonds are in USD. And my future Social Security income will all be in US dollars. So I wouldn't mind putting even 20% of my existing bonds in unhedged international sovereign bonds, but only for a low expense ratio.